Techie

One of the easiest ways to do this is using a software called pebuilder. Using it, you can create an XP Live CD in just about 15 minutes!
Here’s all the software you will need:
1. pebuilder (Get pebuilder)
2. Plugins:
xpe-1.0.7.cab (the GUI shell) from here. Other plugins from here.
3. Nero Building ROM
4. A (bootable) XP CD

Step #1 Download Pebuilder and install it.

Step #2 For the wallpaper, replace c:\pebuilder3110a\bartpe.bmp with the image you want as your wallpaper. You can find the default XP wallpaper at c:\windows\web\wallpaper\bliss.bmp (Both these, of course, assume the C drive as the installation location.)

Step #3 Download the plugins:
xpe-1.0.7.cab: This will create the XP start button and taskbar. It is the GUI shell of the XP live CD.
Network Driver Plugin Pack: This provides many network card drivers.
FreeAV Virus Scanner: This integrates FreeAV.
diskexplorer_for_ntfs.cab: A very good file explorer
You can choose you want to download to add functionality.

Step #4 Open pebuilder. Specify the source path to the windows installation file. This should be your Windows XP installation bootable CD, where the i386 folder resides.

Step #5 Click Plugins and add the plugins you have downloaded. Since you have included xpe-1.0.7.cab, disable nu2shell and the startup group.

Step #6 Specify the ISO image file and click Build.

Step #7 After that is done, use Nero (or any other burning software) and burn the image.

Source: Digit Magazine November 2007